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The Hard Assets Alliance Blog

Current Low-Price Environment Fertile Ground for Rebound

Of the many things to celebrate this holiday season, gold’s performance over the last 12 months isn’t one of them. Barring a “Miracle on Wall Street,” 2013 will go into the books as the yellow metal’s first annual loss in 13 years.

Gold’s performance as of late is surprising, to say the least. Public debt levels continue to swell, currency debasement remains in vogue, and the East’s appetite for bullion is as insatiable as ever, and yet gold will likely close the year down around 20%.

Despite a promising long-term outlook, it would be foolish for us to declare current levels as the bottom. It would equally imprudent to ignore the numerous catalysts conspiring to drive prices higher, especially since there is now one more reason to accumulate gold: lower prices. We don’t simply mean bargain deals. Today’s low price environment is sowing the seeds of a serious supply crunch, and you know what that means.

The Trend Is in Play—Expect the Gold Supply to Decline

As Jeff Clark pointed out in his article in last month's issue, mining companies don’t operate in a vacuum. When prices fall, new projects get shelved and exploration budgets are gashed. The effect is particularly severe when coupled with higher operational costs. Tighter margins are one reason the number of drill projects fell 52% through the first nine months of 2013 compared to the same period last year.

Not only is less getting mined, but producers large and small are resorting to “high-grading” to stay afloat, which essentially means digging up only the good stuff. The strategy can be a life-saver for struggling companies; however, it can also further tighten supply by making it only economical to mine low-grade ore at very high prices, if ever. To compound matters, contentious politics, labor disputes, and environmental roadblocks have injected a heavy dose of uncertainty into an already volatile business.

Though it’s true that global output has been on the rise since 2006, production levels are still 12.8% below year 2000 levels even though gold trades more than 335% higher than it did at the turn of the century. More recently, the global gold supply fell 3% year over year during the third quarter, according to the World Gold Council.

Chinese Demand to Further Widen Fundamental Supply Gap

Of course, no discussion of the gold would be complete without mentioning China. Though it is the world’s leading producer, China doesn’t export any of its bullion, and it isn’t expected to change its hoarding ways anytime soon. The Ministry of Industry and Information Technology projects that Chinese production will increase 25% between 2011 and the end of 2015; however, 450 metric tonnes of domestic output won’t even come close to matching demand, which is forecast to reach 1,000 metric tonnes by that time. To satisfy its hunger, China will need to continue to import massive quantities of gold.

For an industry already facing serious challenges, reduced exploration budgets and the diminishing likelihood of major discoveries mean that it will likely be years before production capacity is rebuilt. For investors who position themselves early, this looming supply crunch has the potential to be very rewarding. As they say, the cure for low prices is low prices.


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